Determine how scarcity and choice influence individual economic decision-making.

In every economic system, there are “productive resources,” or “factors of production.” These include raw materials, factories, equipment, skilled and unskilled labor, etc. These resources, sometimes referred to as capital, are used to add value to other resources, create new goods, or offer services that people want. When the means of production are limited, individuals have to compete to use them. Correspondingly, when they are richly available, there is less competition for the ownership or control of productive resources.

The availability of productive resources and the ways in which they are distributed are fundamental to the workings of an economic system. As will be discussed in objective 5 of this lesson, the private or public ownership of the means of production is one of the key distinguishing features between capitalism, socialism, and communism. Marx argued that economic history is replete with stories of worker exploitation by the wealthy elite who own and control economic capital. Alternatively, when ownership of capital is broadly distributed, all workers can be capitalists, using their own resources to add value to goods and services that other people want to purchase.

At the individual level, the effects of scarcity and abundance are probably more familiar to you. Suppose that the number of people who want to purchase a new video game device exceeds the number of devices produced by the manufacturer (an occurrence which seems to happen every Christmas season). When this occurs, the price for the device goes up because customers compete with — or out-bid — each other to purchase the limited supply of devices available before Christmas. When this occurs, customer demand is said to exceed the available supply of a good or service.

Because the manufacturer of the video game in the above example can make more money by selling more devices even after the holiday season, it will produce more of them. If the manufacturer has the capacity, it will continue to produce more until everyone who is willing to pay the manufacturer’s minimum selling price has purchased one. As the manufacturer produces more and more devices, the price will go down, eventually resulting in a near perfect balance between supply and demand (that is, the number of devices produced equals exactly the number of people willing to purchase the device at the lowest price the manufacturer is willing to charge).

In this simple example, the manufacturer has the ability to purchase more raw materials and hire more people to produce more video game devices. However, in many situations, producers of goods and services do not have that luxury. The supply of some goods and services are naturally limited by the scarcity of the raw materials or expertise required to provide them. In such cases, a good or service might be under-provided by the free market because the demand is greater than the supply. If demand remains high, the manufacturer or its competitors will seek to develop greater capacity to produce the under-provided good or service or develop an acceptable substitute for it. The existence of other businesses or individuals who can also provide the same or very similar goods and services in a free market economy leads to efficiency because businesses cannot simply provide only the amount of a good or service they choose and charge whatever price they want. In a free market economy, the interaction between multiple providers of a wide variety of competing and complementary goods and services and the customers who pay for those goods and services in an economy naturally brings balance to supply and demand. In some economic systems, as will be discussed later in this lesson, governments attempt to facilitate this balance through the control of capital and price setting.

Every day in millions of different ways, the scarcity or abundance of natural resources, labor capacity, goods, or services impact the economic decisions made by individuals, which in turn shape local, national, and global economic conditions. Historically, a variety of approaches to economic regulation and control have been attempted. Governments have attempted to control supply of particular goods and services to meet demand. Some have even attempted to control demand by setting prices. Such efforts, however, are generally unsuccessful because they assume an ability to collect and analyze information that is not humanly possible, regardless of available computer power. The efficiency of a free market is based on the generally unregulated choices of millions and millions of individuals making billions of transactions a day. These transactions are regulated by what Adam Smith called the “invisible hand” (The Wealth of Nations, 1776). Smith argued that as people interacted in a free market economy, the individual pursuit of self interest would produce the best possible economic outcomes for both individuals and society.

From a public policy standpoint, it is tempting to create rules and regulations regarding the scarcity or abundance of particular commodities, services, or resources. However, in the United States economic system, the general tendency is to avoid such economic meddling, leaving the regulation of supply, demand, and prices to the decisions of individuals. There is broad public support for such an approach to the economy. In a Pew Research Center poll, 81 percent of those surveyed believed that the free enterprise system is a “major reason that America has been so successful in this century.” Seventy-six percent of those surveyed agreed that the “strength of this country today is mostly based on the success of American business” and 89 percent said that they “admire people who get rich by working hard” (The Pew Research Center. 1999 Millenium Survey).